Though both financing options offer a revolving credit line, a line of credit and credit card are quite different. While a credit card is best for small, everyday purchases, a line of credit often offers a larger credit limit to use for bigger projects.
When you’re short on cash, there are a few options to help you receive the financing you need. You could apply for a line of credit (LOC) from a financial institution, or use a credit card to borrow money. So which is the better option?
Both of these financing methods are revolving accounts that allow you to borrow money and pay it back with interest over time. But despite the similarities, there are some differences between the two that can affect your decision. And though credit cards tend to be the more popular option, there are circumstances where you might find lines of credit to be the more attractive choice. Let’s take a look at the pros and cons, and explore what each option entails.
Key differences between a credit card and a line of credit
Despite some similarities, credit cards and lines of credit vary quite a bit in how they can be used and accessed. Here are some noteworthy differences between a credit card and a line of credit:
- Accessibility. Whether you’re using a physical card or one from your virtual wallet, credit cards are easier to make purchases with. Using your credit card may even result in rewards points, which LOCs don’t offer.
- Credit limits and terms. The annual percentage rate (APR) on a line of credit is generally lower than that of a credit card. And the credit limit on a line of credit tends to be higher. This makes LOCs better suited for large expenses.
- Application process. Though you should still be honest about your current finances, most credit card applications don’t need any proof of income. This makes the application process for a credit card easier than a line of credit, which tends to require some kind of proof regarding your income.
How a line of credit works
A line of credit is a kind of revolving debt with a preset borrowing limit that you can tap into at any given moment. Unlike a loan, which provides a lump sum of money upfront, a line of credit provides access to funds that can be used as needed. This means you can borrow only what you need so that you won’t have to pay interest on the amount you don’t use.
For example, let’s say you’re remodeling your home and need to pay the contractors $10,000 upfront and $10,000 after the work is done. Instead of taking out a $20,000 loan from day one and paying interest on the entire amount, you can open a credit line with a limit of, say, $30,000. With a line of credit, you can just borrow $10,000 initially and another $10,000 later on. This way, you can avoid accruing unnecessary interest charges while your home is still under renovation.
Apart from home renovations, LOCs can be used for a variety of other purposes. This includes education expenses or even business start-up costs. And though a line of credit is a great financing method, remember that it’s still a loan at the end of the day and should be repaid according to the terms of the agreement.
Different lines of credit
Depending on your personal situation, there are a few types of LOCs to choose from. Here are some of the most common types of LOCs:
- Home equity line of credit. Also known as a HELOC, a home equity line of credit is a secured credit line that is backed by the equity in your home. Though HELOCs typically have low-interest rates and high credit limits, defaulting on this type of LOC means you could possibly lose your property.
- Personal line of credit. Unlike a HELOC which is secured by collateral, personal lines of credit are unsecured. They can have lower interest rates than credit cards, making them a more affordable option for funding large purchases or covering unexpected expenses.
- Business line of credit. A business line of credit is a flexible financing option that can be used for a variety of business purposes. Companies can borrow up to a certain credit limit and only repay the portion they’ve tapped into.
If you’re not sure what a future project will cost and don’t want to take out more than you need, you may want to consider a business line of credit. Be sure to compare your options below before applying.
Line of credit pros and cons
A line of credit can be a great way to borrow money with flexible terms. But as with any other financing method, it comes with its benefits and risks.
Here is a list of the benefits and drawbacks to consider.
- Lower interest rates. LOCs tend to have lower interests compared to credit cards — making them a much more affordable way to borrow money. Not to mention that if you put collateral on the line — by taking out a HELOC, for example — you can enjoy an even lower interest rate.
- No cash advance fees. Credit advance fees are what the credit card issuer charges when you take out cash against your credit limit. This can be anywhere from 3% to 5% of the total cash advance amount. Unlike a credit card, you don’t typically need to pay to access cash from your line of credit.
- Higher credit limits. Generally speaking, LOCs have a higher credit limit compared to credit cards — though it’s ultimately up to the financial institution to determine how much to lend you.
- Not as convenient. With a credit card, you can simply swipe your card at the cash register or input the numbers on the card to make a purchase. Accessing cash with a line of credit is not so simple. You may need to transfer funds to your bank account or even write a check.
- No grace period. Unlike a credit card, a line of credit doesn’t come with a grace period. This means interest charges will start accruing as soon as you draw money from it.
If you’re looking to finance a larger project, such as a house flip or some simple renovations, a HELOC could be right for you. Take a look at some of your options below to ensure you get the best bang for your buck.
How a credit card works
A credit card is a revolving credit that allows you to borrow money up to a certain limit and make purchases on a regular basis. Because you typically don’t need to provide any collateral for the money you borrow, credit card issuers may charge higher interest rates to offset the increased risk of default. In early 2022, the average interest rate for credit cards in the United States was 16.17%.
To get a credit card, you must first apply for one from a financial institution, such as a bank or credit union. If the application is approved, you’ll be given a credit limit, which is the maximum amount that can be borrowed. After making purchases with a credit card, you’ll receive a statement for each billing cycle. You can either pay the full balance each month or make minimum payments. However, if the balance is not paid in full, the outstanding balance will accrue interest at the stated APR.
Credit card pros and cons
Not sure if a credit card is right for you? Here are some pros and cons of this financing method to help you make the most informed decision.
Here is a list of the benefits and drawbacks to consider.
- Rewards and benefits. Many credit cards offer cash back or points for every purchase you make. You can redeem these rewards for travel, merchandise, or cash back. Some cards also come with other perks, such as extended warranty protection or purchase protection.
- Widely accepted payment option. Mastercard, Visa, American Express, and Discover credit cards are accepted at almost every store worldwide.
- Interest-free grace period. Most credit cards offer a grace period of 21 days where you can pay off purchases without having to pay interest. This can be a great benefit if you use your card for everyday expenses and are able to pay off the balance each month.
- High cost of borrowing. One of the biggest drawbacks of using a credit card is the high cost of borrowing. Credit card companies typically charge interest rates of 16% or more, which can add up quickly over time.
- Additional fees and hidden charges. Many cards charge a fee for balance transfers, cash advances, and even foreign transactions. Late payment fees are also common.
If used appropriately, a credit card can be a great way to make small purchases while rebuilding your credit score. One of the best ways to do that is through a secured credit card, which requires a security deposit as collateral.
Line of credit vs. credit card: Which is right for you?
Ultimately, which type of credit is right for you will largely depend on your personal preference and financial needs. That said, here are some general guidelines that can help you make a decision:
Lines of credit typically have lower interest rates than credit cards and can offer a more affordable way of borrowing. For this reason, a line of credit may be a better choice if you’re looking for a way to finance a large purchase or consolidate multiple debts.
Credit cards, on the other hand, are easier to get and can be conveniently used for everyday purchases. However, credit cards typically have higher interest rates than lines of credit — though you can avoid paying interest charges by consistently paying your bill in full each month.
|Credit card||Personal line of credit||Personal loan|
|Interest rate range||8.99% – 29.99%||7% – 20%||5.99% – 35.99%|
|Type of interest rate||Variable||Variable||Fixed|
|Type of credit||Revolving||Revolving||Installment|
|Secured or unsecured?||Both||Both||Both|
|Term length||Continuous||Varies||12 – 84 months|
|Best to use for…||Small, everyday purchases:|
• Clothes shopping
|Larger purchases with a long schedule:|
• Home improvements
• Expensive ongoing medical treatments
|Large purchases with a known value:|
• Consolidating debts
• Wedding or anniversary party
How can I pay off my line of credit quickly?
If you want to pay off your line of credit as soon as possible, there are a few things you can do. First, try to make more than the minimum monthly payments each month. This will help to reduce the principal balance more quickly. Also, try to avoid using your line of credit for unnecessary purchases. Use it only for items that are essential or that’ll help you save money in the long run. Lastly, make sure to keep track of your spending so that you can allocate enough funds to pay off your credit lines.
Does a line of credit count as debt?
Yes, a line of credit is considered a form of debt. It allows you to access a certain amount of funds, up to a maximum limit, and then repay those funds (with interest) over time.
Similar to other forms of debt, if you default on a line of credit, there are consequences. Not only could it drastically decrease your credit score and leave a stain on your credit report, but also negatively affect your chances of qualifying for other financing methods in the future.
That said, be sure to thoroughly understand the terms of a line of credit before taking one out.
Is it better to pay off a credit card or a line of credit first?
Here’s the general rule of thumb when it comes to tackling debt: Pay down the debt with the highest interest first. In this case, you might want to start by targeting your credit card debt. By prioritizing the debt with the highest interest rate, you’ll save money on interest charges over time. This way, you can redirect those funds towards repaying other debts or save them for the future.
In some cases though, paying off the debt with the highest balance first might make more financial sense. For example, if you want to qualify for other loans, you can improve your credit score by lowering your credit utilization ratio.
- Though there are many similarities between a line of credit and a credit card, one might meet your financial needs more than the other.
- Lines of credit typically offer lower interest rates and higher credit limits. However, using a line of credit isn’t as convenient as using a credit card. There’s also no grace period.
- Credit cards can be great because they offer reward programs and a convenient way of payment. But the cost of borrowing with a credit card tends to be higher than other methods.
- Both forms of financing can be great options depending on your needs. Be sure to consider the benefits and drawbacks of both credit cards and lines of credit before choosing one.
View Article Sources
- What’s a Credit Inquiry? – Consumer Financial Protection Bureau
- Available Credit: How Important Is My Credit Score? – FICO
- Will Closing Credit Cards I Already Have Increase My Credit Score? – Consumer Financial Protection Bureau
- Credit 101: The Basics of Credit – SuperMoney
- What Are The Most Popular Types of Credit? – SuperMoney
- Line of Credit vs. Letter of Credit: What’s the Difference? – SuperMoney
- Home Equity Loan vs. Line of Credit: Which Should You Choose? – SuperMoney
- Personal Loan Vs. Line Of Credit: Which Is Better? – SuperMoney
- Personal Loans vs Credit Cards: Things You Should Know – SuperMoney